The federal consumer agency is sounding warning bells about the growing debt Canadians are taking on through auto loans.
Consumers have been taking advantage of stretched amortization periods in recent years to take on more debt without increasing their monthly payments, the Financial Consumer Agency of Canada revealed Tuesday in a research report tracking market trends.
But they are often buying more car than they can afford, paying much more interest, and, in some cases, going on to buy new cars before the original loans are fully repaid.
“In these circumstances, consumers put themselves in the position of having to roll the debt owing on the long-term loan into the loan for the purchase of the new vehicle, thereby potentially stepping onto an ‘auto-debt treadmill',” the agency warned.
The FCAC conducted research in the summer and fall of last year in a targeted review that tapped the country's biggest banks for information, as well as smaller lenders focused on the auto sector.
Particular attention was paid to the information consumers receive about the terms of their auto loans, and to issues with potential impact on consumers, such as “negative equity” and non-prime lending, the report said.
“Recent trends in extended-term car loans have raised several concerns,” said Lucie Tedesco, commissioner of the FCAC. “Consumers must carefully examine their needs and their financial situation to ensure they can repay their car loans without undue strain, and with a full appreciation of the total interest charges and value of the car throughout the loan period.”
The FCAC called the growth in long-term car loans “worrisome,” noting that the average new car loan last year had a term longer than 72 months, up from about 65 months in 2010.
In the same five years, the share of consumers trading vehicles with “negative equity” has risen by 50 per cent – up to 30 per cent of consumers in 2015 from 20 per cent in 2010.
“Although significantly more consumers are carrying negative equity when they break their existing auto loans, the average amount of negative equity carried by consumers who are underwater … has hovered around $6,700,” the report says.
Vehicles depreciate quickly, which means the negative equity peaks in the early years of a loan when the portion of each payment dedicated to interest tends to be larger. Holding the loan longer eventually moves the borrower into a “positive equity” position. That typically happens by the fourth year in a standard 60-month auto loan, but the longer loans leave many borrowers in negative equity positions into the fifth year and even well beyond it, the report says.
The FCAC is not the first to zero in on auto lending as an area of concern. Debt-ratings agency Moody's Investors Service raised similar red flags in 2014.
In a report that fall, Moody's noted that auto lending by banks had grown at a compounded annual rate of 20 per cent since 2007, “significantly outpacing” the growth of even red-hot mortgages, credit cards, and lines of credit. In seven years, vehicle loans had jumped to $64 billion from $16.2 billion.
The authors of the Moody's report warned that with household debt already at record levels, the concerted push into auto lending – buoyed by low interest rates and longer amortization periods that reduced a buyer's monthly payments — had exposed Canadian banks to the risks of soured loans and lower recovery rates in the event of a downturn.
“Since our report, both consumer debt levels and auto loans at Canadian banks have increased,” Jason Mercer, one of the authors of the Moody's report, said Tuesday. “Today, Canadian consumers face increased uncertainty due to persistent low oil prices and potential housing overvaluations, so these risk remain as relevant as ever.”
The Financial Consumer Agency of Canada says consumer groups have also expressed concern, and it is responding by focusing oversight and education efforts on the auto loan market.
One step will be to ensure the indirect lending activities of federally regulated financial institutions, including auto loans, comply with federal legislative and regulatory requirements.
According to the FCAC report, long-term car loans – those of six years or more — constitute about 60 per cent of the car loan portfolios of Canada's largest financial institutions.
The Agency is also collaborating with provincial and territorial governments to ensure that consumers receive the information they need when entering into a car loan.